The stock market is not the economy in an important way 🌎
Plus a review of the macro crosscurrents 🔀
The U.S. economy is closely related to the U.S. stock market. But that relationship is not perfect in a number of ways.
An important way the two differ is international exposure.
According to FactSet, S&P 500 companiesgenerate around 40% of revenue outside of the U.S. That means these companies are significantly dependent on the health of the international economies in which they operate. They employ abroad, source goods abroad, and sell abroad.
This is not to say the U.S. economy is totally decoupled from the rest of the world: Annual exports account for $3 trillion of the $25 trillion worth of U.S. GDP.
But when you think of the U.S. economy, you generally think about activity inside the borders of the U.S. This includes U.S. employment levels, U.S. manufacturing activity, U.S. services sector activity, etc. This, by the way, includes non-U.S. companies with footprints in the U.S. like Toyota, B.P., Samsung, and Nestle.
First quarter results were adversely impacted by global volume softness that accelerated in the final weeks of the quarter. FedEx Express results were particularly impacted by macroeconomic weakness in Asia and service challenges in Europe, leading to a revenue shortfall in this segment of approximately $500 million relative to company forecasts. FedEx Ground revenue was approximately $300 million below company forecasts.
FedEx is one of the so-called “early reporters” — that is, companies whose quarters end a month earlier than most companies. The last two months of FedEx’s quarter overlaps with the first two months of most companies’ Q3. And so the company’s warning may serve as a leading indicator for the upcoming Q3 earnings season, which kicks off in mid-October.
As Asia struggles with COVID-related lockdowns and Europe wrestles with surging energy costs, companies with significant exposures in these regions may underperform those with greater dependence on the U.S., where the economy has been resilient.
There’s also the matter of the surging U.S. dollar, which is leading to the dollar value of revenue generated abroad shrinking for U.S.-based multinational companies. Morgan Stanley analysts recently estimated that every 1% increase in the dollar index represents a roughly 0.5% reduction in S&P 500 earnings per share.
While dollar strength may be good news for U.S. importers and American vacationers traveling abroad, it’s bad news for everyone else watching their own currencies lose purchasing power in the international markets.
All of this raises doubt about analysts’ current forecasts for earnings growth, which appear at risk of getting revised down further. This is a big deal because, as TKer readers know, earnings are the most important driver of stock prices over the long run.
For investors and traders, the key question is what’s priced into the markets. The strong dollar and economic weakness abroad are known stories that have weighed on markets for a while. So, while these are clear headwinds, it’s very possible to see markets climb as analysts factor in the deteriorating macro backdrop into their earnings forecasts.
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Reviewing the macro crosscurrents 🔀
There were a few notable datapoints from last week to consider:
🎈 Inflation is still high. The consumer price index climbed 0.1% month over month in August, unexpectedly accelerating from 0.0% in July. Economists had expected the metric to decline 0.1% amid falling energy prices. While energy prices indeed fell during the period (gasoline prices tumbled 10.6%), prices for food and shelter remained hot, rising 0.8% and 0.7%, respectively. Excluding food and energy prices — which tend to be more volatile in the short run — core CPI growth unexpectedly accelerated to 0.6% in August from 0.3% in July. On a year-over-year basis, CPI was up 8.3% (hotter than expected), and core CPI was up 6.3% (also hotter than expected).
📉 Expectations for inflation are coming down. From the University of Michigan’s September Survey of Consumers: “With continued declines in energy prices, the median expected year-ahead inflation rate declined to 4.6%, the lowest reading since last September. At 2.8%, median long run inflation expectations fell below the 2.9-3.1% range for the first time since July 2021.“ The New York Fed’s August Survey of Consumer Expectations released Monday echoed this sentiment. The median expectation for inflation one year ahead was 5.7% in August, down from its June high of 6.8%. From the NY Fed: “Expectations about year-ahead price increases for gas also continued to decline, with households now expecting gas prices to be roughly unchanged a year from now.“
🏪 Small businesses are cooling on prices. From the NFIB: “The net percent of owners raising average selling prices decreased 3 points from July to a net 53% seasonally adjusted.“
💼 The labor market is strong. Even as the economy cools and hiring slows, employers seem to be holding on tight to their employees. Initial claims for unemployment insurance came in at 213,000 for the week ending September 10, down from 218,000 the week prior. While the number is up from its six-decade low of 166,000 in March, it remains near levels seen during periods of economic expansion.
💵 Small businesses are hiring. From Bank of America: “…small businesses continue to see strength in payroll payments. The three-month rolling average of payroll spend per client rose 11% year-over-year (YoY) in August, suggesting robust hiring and wage growth momentum. Restaurant and bar payroll payments may be moderating the most from recent highs, partly reflecting easing wage inflation in leisure & hospitality, but even here 18% YoY growth in August is reassuring.”
🛍 Retail sales are holding up. In August, retail sales unexpectedly climbed by 0.3% month over month. Autos sales climbed 2.8% while gas station sales fell 4.2%. Excluding autos and gas, sales increased by 0.3%, which wasn’t as strong as the 0.5% gain expected. The report reflected strength in “doing stuff” — restaurant and bar sales were up 1.1% — and weakness in “buying stuff” — furniture sales were down 1.3%. Note: Retail sales figures are not adjusted for inflation. Real sales levels are lower.
🛠 Manufacturing cools. Industrial production activity declined by 0.2% month over month in August.
🥶 Manufacturing looks to keep cooling. The Empire State Manufacturing Survey’s general business conditions index and the Philly Fed Manufacturing Business Outlook Survey’s current activity index both registered negative prints in September, suggesting manufacturing activity in the Mideast U.S. continued to contract.
🏡 Mortgage rates top 6% for the first time since 2008. From Freddie Mac: “Mortgage rates continued to rise alongside hotter-than-expected inflation numbers this week, exceeding six percent for the first time since late 2008. Although the increase in rates will continue to dampen demand and put downward pressure on home prices, inventory remains inadequate. This indicates that while home price declines will likely continue, they should not be large.“
📉 Stocks tumbled last week with the S&P 500 falling 4.7% to close at 3,873.33. The index is now down 19.2% from its January 3 closing high of 4,796.56 and up 5.6% from its June 16 closing low of 3,666.77.
Putting it all together 🤔
The strong labor market — marked by low layoff activity — continues to put money in consumers’ pockets, preventing the bottom from falling out of consumer spending. Unfortunately, the strong consumer is part of the reason why inflation has been high.
Indeed, while some price indicators have been easing, inflation remains troublingly high. And so financial markets remain volatile as the Fed increasingly tightens financial conditions in its effort to cool prices. As such, recession risks linger and analysts have been trimming their forecasts for earnings. For now, all of this makes for a conundrum for the stock market until we get “compelling evidence” that inflation is indeed under control.
Best of TKer 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters. All of the headlines are hyperlinked to the archived pieces.
Excess savings represent the extra money consumers have put away since the beginning of the pandemic, thanks to a combination of limited spending options, government financial support, and a run-up in home values and stock prices. It represents money on top of what consumers were on pace to accumulate assuming the pre-pandemic trend rate of saving. However, these savings are also exacerbating two of the biggest challenges in the economy.
With the economy slowing for months, you’d think there’d be more layoffs. But layoff activity remains very low. What gives? Well, we may be witnessing “labor hoarding” on the part of employers. At least some of the employers seeing business slow right now remember how hard it was to recruit talent over the past two years and would rather just hang on to employees, even if it comes with carrying costs.
While the economy may not be in a recession now, it’s certainly slowing and is at risk of going into a recession. However, not every recession has to be an outright economic debacle like the global financial crisis or the Great Depression. Yes, unemployment would likely rise during the next recession, which would be unquestionably painful for those affected. But the losses could be limited and the duration of the economic contraction could be relatively short.
There’s more than one way to frame a piece of economic or financial market data. It might be better than expected relative to economists’ expectations, but it could also be worse than expected relative to traders’ expectations. That same stat could be down on a month over month basis and also up on a year over year basis. It may be high relative to the 10-year average but low relative to the 5-year average. It may look bad on an absolute basis but it may look good relative to what may be the normal course of business. With that in mind, below are nine unsettling — albeit accurate — market observations that miss the point when you take a look at the big picture.
The Fed is actively trying to slow the economy — even if it means “some pain” for businesses and consumers — because it believes that is the prescription for getting inflation under control. In this world, good news about the economy is potentially bad news if it’s exacerbating the dislocation between supply and demand. Let’s review a few hypothetical headlines and examine why good news might be bad news — and vice versa.
Economic growth has since been awesome, powered by tons of job growth. GDP, personal consumption, and home prices roared to record levels as the unemployment rate tumbled. One problem: Inflation. Why? Supply hasn’t been able to keep up with booming demand, a dynamic that’s been fanning the flames of inflation.
While the stock market is likely to generate healthy returns in the long run, there’s good reason for investors to manage expectations in the short run as the Federal Reserve gets increasingly aggressive with monetary policy.
The S&P 500 represents the largest publicly-traded U.S. companies, which generally have more international exposure than smaller cap companies.
Due to flexibility in reporting requirements, there isn’t a perfect way to measure how much revenue each publicly-generated company generates in the various regions in which it operates. As such, estimates regarding foreign exposure vary. For example, Goldman Sachs analysts estimate S&P 500 companies generate around 30% of revenue outside of the U.S.